Surging Tech Stocks, a Hawkish Fed Cut, and Regulatory Shifts

Last week’s market narrative was defined by yet another extraordinary surge in tech stocks, inflation developments generally aligning with expectations, and anticipation of the upcoming Federal Reserve meeting.

The continued dominance of the Magnificent Seven in the equity markets has been striking, underscoring a lack of rotation into value or small-cap stocks despite fleeting moments of activity in those sectors. The Nasdaq climb past the 20,000 level grabbed headlines, with momentum appearing to stem from fund managers seeking to align with benchmarks ahead of year-end reporting. While this tech-led rally persists, a recalibration and rotation is possible in January to reflect more balanced market leadership.

On inflation, the (Consumer Price Index) CPI data landed precisely as predicted, yet the Producer Price Index (PPI) underscored persistent stickiness of inflation. Shelter costs, which weigh heavily on the core CPI, increased by 0.3%. Encouragingly, the critical rental and owner-occupied components saw a more subdued 0.2% rise, though a jump in lodging away from home pushed the overall shelter index higher. With shelter accounting for over 40% of core CPI, a sustained deceleration in housing costs will be vital to easing price pressures. There is still a lagged component in the official BLS metrics and when we substitute real-time rental metrics for BLS shelter, both core and headline CPI are below 2%.

The Federal Open Market Committee (FOMC) meeting this week looms large. I expect the Fed to deliver a rate cut— but a hawkish one. I believe the dot plot may show a large number of members preferring only two cuts next year, and this might jar risk assets. I believe the Summary of Economic Projections (SEP) will reveal long-term expectations of the funds rate will move up to 3.0% or 3.1% or potentially higher. Since the market is expecting a rate cut Wednesday, and there has been no push back by Powell, I think a 25-basis point (bp) cut at this meeting is in the bag, although there might be dissents. Remember, I estimate that the neutral Fed Funds Rate to be 3.5% to 4.0%, far higher than the consensus of FOMC members, but still 50 bps to 100 bps lower than current rate.